'We invest £50 a month for the kids in Junior Isas': Save for children tax free - they really won't waste it on a fast car

By Johanna Gornitzki, Financial Mail on Sunday

Published: 18:18 EDT, 2 November 2013 | Updated: 05:40 EDT, 4 November 2013

More than 366,000 children have a Junior Isa, or Jisa – a fraction of the six million eligible for this valuable savings scheme which can help them save tax-free for many years.

Now Jisas have reached their second birthday, The Mail on Sunday explains how they work and whether it is worth taking one out.

What is a Junior Isa?

It's a mini version of the popular tax-friendly Individual Savings Account, which has been around since 1999. It allows parents – or any other relatives or friends – to save up to £3,720 a year tax free on behalf of a child.

Small beginnings: Matilda and Monty with their parents

Just like the adult version, savings can be put into stocks and shares, cash or a mix of the two. There are no rules on how you divide the annual allowance.

Interest paid on cash Jisas is free of tax and there is no capital gains tax on capital growth, nor is there further tax to pay on income generated by share investments.

A big difference between Isas and Jisas is that a child can only hold their cash Jisa with one provider – the same with a shares Jisa. This means you top up with the same provider each year. However, you can transfer your Jisas to another provider if you see a more competitive deal.

Another difference is that the money is tied up until they turn 18. The account is held in the child’s name but opened and managed by the parents, although the child can take control at 16. At age 18 the money belongs to them to do with as they like. This has made a lot of parents hesitant about putting money into a Jisa.

Patrick Connolly of financial adviser Chase de Vere in Bath, Somerset, says: ‘The concern for parents is that money put aside to pay for university fees or a house deposit could potentially be squandered on foreign holidays and fast cars.’

But such fears may be unfounded as new analysis from discount broker Hargreaves Lansdown shows that only one per cent of children with a Jisa have chosen to cash in their accounts at age 18.

Can all children have one?

No. The Junior Isa replaced the Child Trust Fund when the latter was scrapped for new savers on January 3, 2011. This means that Jisas are only available to children born on or after that date, or children aged under 18 but born before September 1, 2002, when the CTF was introduced – and who never contributed to a CTF.

Parents who have children with a CTF can continue to contribute and can save the same amount each year as in a Jisa.

Is the money accessible?

The savings pot cannot be dipped into until the child reaches age 18. So any parent who expects their children to need the money before then should consider an alternative traditional savings account.

Is it worth opening a Jisa?

It depends. Not every child will benefit from the tax breaks because most children’s investments don’t make enough income to be taxed at all. This is because children, just like adults, have a personal allowance which currently stands at £9,440, which means they can earn that amount each tax year without paying income tax. They also have a £10,900 capital gains tax allowance, so any equity investment would have to grow dramatically before they would be hit with a CGT bill outside a Jisa.

What will happen to old Child Trust Fund accounts?

Any child with a CTF is not permitted to open a Jisa or transfer funds from a CTF to a Jisa, but industry experts are hoping the two will soon be merged. This will be welcomed as most CTFs, because they are closed to new business, offer pitiful interest rates on cash, and the equity CTF providers offer minimal investment options – plus they come with high charges.

Jisas tend to offer better interest rates and a wider, and cheaper, selection of investment options. Jason Hollands, director at broker Bestinvest, says: ‘Moves to allow CTFs to be transferred into Jisas will give parents access to a wider choice of investments including lower-cost options.’

An announcement is expected in the Chancellor’s Autumn Statement early next month.

Which Jisa should I choose?

For cash-based Jisas, it is all about finding the most competitive interest rate. Most banks and building societies offer a cash Jisa. The two top-paying Jisas are from Coventry Building Society and Nationwide Building Society, both paying 3.25 per cent.

But Nationwide’s Jisa includes a bonus of 1.15 per cent until the end of January 2015 when the rate drops to 2.1 per cent, and the maximum investment limit is £10,920. But while two-thirds of parents opt for a cash Jisa, according to Bestinvest, advisers say they should consider investing the money in equities. This is because over the longer term the stock market tends to outperform cash.

Connolly says: ‘When investing for children, many people will be doing it for a significant period, often ten years or more. Where this is the case, investors can afford to take a reasonable amount of risk as they will have plenty of time to claw back any short-term losses.’

Most investment houses and discount brokers, such as Hargreaves Lansdown and Chelsea Financial Services, offer stocks and shares Jisas. But always check charges before choosing a provider.

Gavin Haynes, managing director of the investment adviser Whitechurch Securities, based in Bristol, says: ‘There is typically no set-up or ongoing cost for having a Jisa, but underlying fund charges and stockbroking charges apply.’ Annual fund charges are between 1 and 1.5 per cent but can be reduced by buying via a discount fund broker.